Potential home buyers walk past an ‘Open House’ sign displayed in the front yard of a property for sale in Columbus, Ohio.Ty Wright | Bloomberg | Getty ImagesAnyone out hunting for an affordable home today knows that the pickings are slim – and they are about to get slimmer.Housing inventory hit a record low about two years ago, but a lull in home sales over the past year helped build back much-needed supply, especially in the mid-priced range. Then a sharp drop in rates this summer brought demand back and has depleted that supply dramatically.National housing inventory fell 2.5% annually in September, a sharper decline than August’s 1.8% decrease, according to realtor.comSupply has always been leanest on the low end, as investors have been very active in that price range since the foreclosure crisis.Roughly five million mostly entry-level homes have been turned into single-family rentals, and strong demand for those rentals means investors are unlikely to put the homes up for sale anytime soon.In addition, an unseasonably strong surge in demand at the end of summer and into this fall now has the supply of homes priced below $200,000 down 10% compared with a year ago.The demand is being fueled by lower mortgage rates. The average rate on the 30-year fixed surged over 5% last November and stayed above 4.5% through March, according to Mortgage News Daily. That made for a lackluster spring housing market, traditionally the busiest time for buying.Rates then began falling in May and particularly sharply in July and August. By the start of September the average rate was around 3.5%, and sales of both new and existing homes were surging back. Clearly there was substantial pent-up demand from the spring.Demand also surged in the move-up market, causing supplies there to fall as well. The supply of homes priced between $200,000 and $750,000, which make up 60% of the market, flat-lined in September, after 18 months of strong inventory growth. Supply is now expected to decline in the months ahead.Dwindling options”If, or better yet, when inventory in this segment begins to take a downturn, the vast majority of homebuyers are going to feel its effects as their options rapidly dwindle,” said George Ratiu, senior economist for realtor.com. “September inventory trends, especially in the mid-market, may be the canary in the coal mine that we could be headed for even lower levels of inventory in early 2020.”The nation’s homebuilders are not helping the situation much either. Single-family housing starts have been rising very slowly, but mostly in the move-up and luxury segments of the market.”It’s not just the overall supply of new construction that’s gone down, but the supply of starter homes, so it’s the affordability challenge at the entry level that’s been a particular challenge,” said Robert Dietz, chief economist for the National Association of Home Builders. “Right now only about 10% of newly-built home sales are priced under $200,000. Five years ago that share was 1 in 5, and 10 years ago it was 40% of new home sales were priced under $200,000.”Builders are unlikely to catch up with demand, according to Dietz, who said the market is now undersupplied by about one million housing units. Builders may want to build more at the entry level, but they are not able to given the current costs.”We’ve faced what has been called a perfect storm of supply side challenges,” noted Dietz. “There has been an ongoing labor shortage, we lack the necessary land and lots to build homes, we’ve had building material cost concerns, and then probably the most important factor has been higher regulatory costs since the great recession.”Builders are therefore putting up pricier homes, but that’s the category with the most supply. In fact, the supply of homes price above $750,000 was 4.7% higher in September compared with September 2018.Higher demand for homes and lower supply will likely reignite the gains in home prices. Price gains had been shrinking throughout much of this year, but they have now stabilized, and in some markets the gains are widening again.If mortgage rates should turn higher, then demand could fall back and price gains ease, but if they stay in the current low range, it is very likely that the housing shortage will only get worse, setting the nation up for an incredibly competitive and expensive spring 2020 market.